By Charles Delvalle
I see this mistake all the time: A new trader wants to make big money on a "hot" stock, so he lays down a position that is too large. But all it takes is one mistake... and he can lose most of his trading capital.
Let's say you start with $10,000 in your account, and you put all of your trading capital into each of a series of four trades:
You make 20 percent in your first trade, so now you have $12,000.
You make 30 percent on your second trade, so now you have $15,600.
You make another 20 percent on your third trade, so now you're up to a whopping $18,720.
But then, on your fourth trade, you take a big loss. The company you've invested in reports a lawsuit, and the stock tanks 80 percent. Now you're down to $3,744 - $6,256 less than the $10,000 you started with.
My advice to a new trader who doesn't have a lot of start-up capital is to never put more than 20 percent of his trading capital on any one position - no matter how "hot" the stock seems to be. Let me show you how that would work in the example above:
On your first trade, you would make $400.
On your second trade you would make $624.
On your third trade, you would make $440.
And on that fourth - disastrous - trade, you would lose $1,834.
But you would still have $9,630 in your account, instead of a measly $3,744. In other words, by using no more than 20 percent of your trading capital on each position, you could still take a big loss and have the money to trade another day.
This asset allocation works differently if you are an investor with over $100,000. At that point, you should dedicate no more than 4-5 percent to any single trade.
[Ed. Note: Charles Delvalle is a contributing editor to ETR's Investor's Daily Edge newsletter.]
http://earlytorise.com/archive/html/120906-2.html#brief1Lifted from the post of rma2003 at PMT, http://www.pinoymoneytalk.com/forum/index.php?topic=5083.0Learn More, Watch Video - Get 15-day Free Trial
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